“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

The more index funds get more money, the less money active investors have to move the price enough with big $$$ and correct inefficiencies. So, even though, the chances are zero, the effect can happen at some point in the future.

I think the chance of that happening is also low as far as I can tell.

carofe wrote:The more index funds get more money, the less money active investors have to move the price enough with big $$$ and correct inefficiencies. So, even though, the chances are zero, the effect can happen at some point in the future.

I think the chance of that happening is also low as far as I can tell.

Prices are set at the margin. The amount of money it takes to move the price is no more than whatever the price is.

carofe wrote:The more index funds get more money, the less money active investors have to move the price enough with big $$$ and correct inefficiencies. So, even though, the chances are zero, the effect can happen at some point in the future.

I think the chance of that happening is also low as far as I can tell.

Prices are set at the margin. The amount of money it takes to move the price is no more than whatever the price is.

I think it depends. If most of the daily trading is done by index funds and ETF, the chance of a significant price move by much "smaller" (in context) amount of buy/sell made by active investors is lower. Anyways, I'm just referring to a comment from Mr. Klarman that made sense to me when I read it. So far, I'm not worry about it; yet.

I think that's a valid concern in terms of the Japanese zombie corp experience to one extent. On the other side of it, though, is a dramatic increase in the dispersion of returns between companies. It used to be that you could grab 30-40 blue chips and have a diverse portfolio. Now to get a 5% tracking error, you need almost 100 large caps.

The solution if everyone truly indexed on a cap-weighted basis would be first to detach governance from ownership, by requiring large index funds to split their voting rights between many smaller independent entities. The other thing, and the thing that I think will settle into place for the long haul is a variety of broad and narrow indexing methodologies, most of which involve turnover of one sort or another.

The other thing this that the more extreme investment approach guys (high growth and deep value) would have bigger and bigger advantages in a more inelastic market like this.

Suppose you have a big pot of soup that contains 20% chicken. A line of indexers comes forward. Each one stirs it up thoroughly and takes out a ladleful of soup, containing 20% chicken in their ladleful. Does that ruin it for the people who come afterwards? Does it cause chaos if indexers take 30% of the soup? 50% of the soup? 80% of the soup?

Any other strategy is going to create problems if very, very widely adopted, much sooner than indexing. For example, only 2% of the stock market is small value, so there will be big problems if "everybody" decides they want a 10% small value tilt.

"“Markets are going to be efficient as long as there are managers, or investors, trying to find little holes in the system… price discovery, as they call it,” Bogle said.

“And not to be too negative about it, but it’s certainly not going to happen during my lifetime.”

Bogle turns 88 on Monday."

Mr. Bogle is right. If no one traded, markets would not operate. However, it takes very few participants to make a market work and if we hit the point where the market didn't work (became inefficient), more active participants would step in an start trading to make money off of the inefficiency.

The system would fix itself before it even became a noticeable problem.

Anything that can't go on forever won't do so in the real world. If there is a percentage at which indexing becomes less efficient than stock picking or other strategies, indexing will presumably not grow to a higher percentage than that value. Doesn't matter whether that percentages is 50%, 80%, or 95%, the market will presumably find it...

“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

“Now, what are the chances of everybody indexing? It’s zero.”

Yeah, but combine indexing with the Japanese and Swiss central banks buying ETFs, and you could get a problem a lot quicker than expected.

I would be more worried if nearly everyone started using a momentum strategy. It seems like it would take a very high proportion for regular indexing to destroy price discovery. Even in the Boglehead forum there are probably enough members dabbling in speculative stock picking that the market could survive if everyone followed suit.

Everyone indexing is not the same as no buy/sell transactions taking place. Indexers do sell stocks. So there would still be price setting going on, on a daily basis. Isn't the real problem that there would be lack of inventory/high demand. Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

Danzangdc wrote:Everyone indexing is not the same as no buy/sell transactions taking place. Indexers do sell stocks. So there would still be price setting going on, on a daily basis. Isn't the real problem that there would be lack of inventory/high demand. Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

While there would be trading there would be no price discovery. Index funds are passive traders, they buy and sell at the market. Information traders are different - Is this stock priced too high, is it priced to low? It is this type of trading that makes the market efficient - pushing stock prices to the correct level. If everybody just bought the market as their paychecks rolled in we would get another tulip market.

Danzangdc wrote:Everyone indexing is not the same as no buy/sell transactions taking place. Indexers do sell stocks. So there would still be price setting going on, on a daily basis. Isn't the real problem that there would be lack of inventory/high demand. Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

While there would be trading there would be no price discovery. Index funds are passive traders, they buy and sell at the market. Information traders are different - Is this stock priced too high, is it priced to low? It is this type of trading that makes the market efficient - pushing stock prices to the correct level. If everybody just bought the market as their paychecks rolled in we would get another tulip market.

If no one in the market is speculating how could it result in a tulip market-like event?

It seems intuitive that if there are fewer price setters in the market then we could see more short-term price volatility, but if you buy and hold for the long haul, then how much does short-term volatility matter?

Danzangdc wrote:... Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

While there would be trading there would be no price discovery. ... If everybody just bought the market as their paychecks rolled in we would get another tulip market.

If no one in the market is speculating how could it result in a tulip market-like event?

Why do we invest? Because we expect real economic return in the underlying assets. If we just buy because everybody else is, because that will drive up demand, because that will drive up prices, that is the definition of speculation. The greater fool will by my shares at a higher price. Because we all act like zombies, following the crowd.

If you want a more contemporary example look up the "Nifty Fifty". Everybody bought those 50 stocks because they always went up, so everybody bought those stocks, so they went up. Until they didn't.

Danzangdc wrote:... Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

While there would be trading there would be no price discovery. ... If everybody just bought the market as their paychecks rolled in we would get another tulip market.

If no one in the market is speculating how could it result in a tulip market-like event?

Why do we invest? Because we expect real economic return in the underlying assets. If we just buy because everybody else is, because that will drive up demand, because that will drive up prices, that is the definition of speculation.

That isn't the definition of speculation - it is missing the the 'significant risk of loss' and 'expectation of substantial gain' - indexers by definition are looking at average gains and average risk. And of course if all trade is solely driven by liquidity needs supply and demand will both increase/decrease independent of speculation on future prices.

The greater fool will by my shares at a higher price. Because we all act like zombies, following the crowd.

That isn't at all what we are acting like. We are buying shares in productive business with real intrinsic value (even if it is hard to forecast because the future is uncertain) - heck in this hypothetical businesses would probably move towards increased use of dividends and price change may be less of a factor of total return.

If you want a more contemporary example look up the "Nifty Fifty". Everybody bought those 50 stocks because they always went up, so everybody bought those stocks, so they went up. Until they didn't.

Except they were bought in a method that looks nothing like index investing. J

Danzangdc wrote:Everyone indexing is not the same as no buy/sell transactions taking place. Indexers do sell stocks. So there would still be price setting going on, on a daily basis. Isn't the real problem that there would be lack of inventory/high demand. Everybody would be looking to buy more stocks when their paychecks came in, but only a small portion of people would be looking to sell. Prices would jump!

While there would be trading there would be no price discovery. Index funds are passive traders, they buy and sell at the market. Information traders are different - Is this stock priced too high, is it priced to low? It is this type of trading that makes the market efficient - pushing stock prices to the correct level. If everybody just bought the market as their paychecks rolled in we would get another tulip market.

“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

I agree with others that my understanding is currently that indexing is already having an impact, making the market less sensitive to company-level changes. However, the amount of funds indexed is around 25% currently, right? If so, we're probably a bit aways from the tail fully wagging the dog, which would ultimately lead to unknown bubbles as valuations wouldn't be pegged to individual companies, thus creating such error that things will inevitably become unstable.

That said, I think with the number of people that LOVE to pick stocks and be active, before crashing the market indexing is likely to create more and more opportunities for active investors, which I think will provide a stabilization/balance to the system. Think about it - if Alphabet were to be become as expensive as a no-name start up because too many people were just passively buying a tech index or TSM, there would be more active investors willing to be specific and buy Alphabet. Given the likely difference between the two, as long as SOME individual stock performance difference remained, the Alphabet folks would likely win, encouraging more active investors, etc.

In other words, I think the system will be self-correcting because the financial opportunities presented in a highly-indexed market would become more pronounced with higher levels of indexing.

“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

“Now, what are the chances of everybody indexing? It’s zero.”

To get into the nuts and bolts of this, I need some education, if you please...

Correct my thinking if I am wrong: Say you put $100k into VG's S&P500 Index fund. That $100k is taken by the VG traders and used to actually BUY stocks of companies that are in the S&P500 Index, right? So in effect, you are buying an index fund, yes... but there is active trading going on underneath it all in order for you to own "the index". It is just that someone else is doing the low-level stuff (the buying).

When you sell an index fund, the above is happening in reverse, right?

So in truth, while all this buying and selling of "index funds" is going on, there is the usual, almost day-to-day type of stock trading going on underneath it all, right?

So even if everyone switched from active investing (owning the individual stocks) to owning index funds, there would still be buying and selling of those index funds occurring in an ongoing fashion (even long term index fund "holders" eventually sell/buy for various reasons) and thereby the trading of the securities being held by those index funds.

Am I misunderstanding how it all works, in practice?

“Where you stand, depends on where you sit” - Rufus Miles | "Never underestimate one's capacity to overestimate one's abilities"

“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

“Now, what are the chances of everybody indexing? It’s zero.”

To get into the nuts and bolts of this, I need some education, if you please...

Correct my thinking if I am wrong: Say you put $100k into VG's S&P500 Index fund. That $100k is taken by the VG traders and used to actually BUY stocks of companies that are in the S&P500 Index, right? So in effect, you are buying an index fund, yes... but there is active trading going on underneath it all in order for you to own "the index". It is just that someone else is doing the low-level stuff (the buying).

When you sell an index fund, the above is happening in reverse, right?

So in truth, while all this buying and selling of "index funds" is going on, there is the usual, almost day-to-day type of stock trading going on underneath it all, right?

So even if everyone switched from active investing (owning the individual stocks) to owning index funds, there would still be buying and selling of those index funds occurring in an ongoing fashion (even long term index fund "holders" eventually sell/buy for various reasons) and thereby the trading of the securities being held by those index funds.

Am I misunderstanding how it all works, in practice?

I think the issue is how do real-life events that should influence an individual company's stock get priced in when you can only make decisions to buy or sell the whole index. If Amazon has higher than expected profits or an auto manufacturer issues a major recall, how does that get reflected in their stock price if everyone has instructed the underlying traders to simply hold an amount equal to their market cap?

dspencer wrote:I think the issue is how do real-life events that should influence an individual company's stock get priced in when you can only make decisions to buy or sell the whole index. If Amazon has higher than expected profits or an auto manufacturer issues a major recall, how does that get reflected in their stock price if everyone has instructed the underlying traders to simply hold an amount equal to their market cap?

Well, in the short term it would barely be a blip. But over the longer term, companies get added and deleted from the Indexes all the time. That would be a way of rewarding or punishing those companies for their behaviors, wouldn't it?

And there are lots of indexes, right? With VG we are only exposed to some of them. Over time, evermore indexes could be created which would pigeonhole companies into other, overlapping niches. As the divisor (total number of companies in an index) gets smaller, the net effect of any one of the company's decisions which might cause a big move in its stock price can more affect the value of the index as a whole, with resulting index owner reaction.

It is still all about buying and selling at a nominal level. Even with indexes that shouldn't go away.

“Where you stand, depends on where you sit” - Rufus Miles | "Never underestimate one's capacity to overestimate one's abilities"

BolderBoy wrote:Well, in the short term it would barely be a blip. But over the longer term, companies get added and deleted from the Indexes all the time. That would be a way of rewarding or punishing those companies for their behaviors, wouldn't it?

And there are lots of indexes, right? With VG we are only exposed to some of them. Over time, evermore indexes could be created which would pigeonhole companies into other, overlapping niches. As the divisor (total number of companies in an index) gets smaller, the net effect of any one of the company's decisions which might cause a big move in its stock price can more affect the value of the index as a whole, with resulting index owner reaction.

It is still all about buying and selling at a nominal level. Even with indexes that shouldn't go away.

The question is basically: if everyone wants to own the same companies in the proportion to their market capitalization and doesn't even bother reading news on individual companies, then how do a company's decisions ever cause a big move in their stock price in the first place? How do real world results get translated into higher or lower stock valuations if everyone has the same philosophy to own the market.

The real world is much more complex and makes it hard to analyze what would happen in these hypothetical scenarios. I think if the trend towards indexing ever becomes strong enough to create issues it will very quickly be balanced by active traders taking advantage of the inefficient market. Maybe at some point we start seeing articles about how active funds finally beat the index funds and then the trend reverses a bit.

“If everybody indexed, the only word you could use is chaos, catastrophe,” said Jack Bogle, founder of Vanguard, at the Berkshire Hathaway annual meeting on Saturday.

“There would be no trading,” Bogle told Yahoo Finance editor-in-chief Andy Serwer. “There would be no way to turn a stream of income into a pile of capital or a pile of capital into a stream of income.

“Now, what are the chances of everybody indexing? It’s zero.”

To get into the nuts and bolts of this, I need some education, if you please...

Correct my thinking if I am wrong: Say you put $100k into VG's S&P500 Index fund. That $100k is taken by the VG traders and used to actually BUY stocks of companies that are in the S&P500 Index, right? So in effect, you are buying an index fund, yes... but there is active trading going on underneath it all in order for you to own "the index". It is just that someone else is doing the low-level stuff (the buying).

When you sell an index fund, the above is happening in reverse, right?

So in truth, while all this buying and selling of "index funds" is going on, there is the usual, almost day-to-day type of stock trading going on underneath it all, right?

So even if everyone switched from active investing (owning the individual stocks) to owning index funds, there would still be buying and selling of those index funds occurring in an ongoing fashion (even long term index fund "holders" eventually sell/buy for various reasons) and thereby the trading of the securities being held by those index funds.

Am I misunderstanding how it all works, in practice?

I think the issue is how do real-life events that should influence an individual company's stock get priced in when you can only make decisions to buy or sell the whole index. If Amazon has higher than expected profits or an auto manufacturer issues a major recall, how does that get reflected in their stock price if everyone has instructed the underlying traders to simply hold an amount equal to their market cap?

Every buyer needs a seller - so someone is determining the price. Even if we assume all money is invested to track indexes the people managing that money (and thus executing the trades as needed) will be setting price against someone else on the other end of the trade - why wouldn't those prices be influenced by real-life events just as today?

KyleAAA wrote:If everyone else indexed, I would become an active trader and make a fortune. I really hope that happens.

^^^^ THIS!

[edit] Or to put it another way, it will never happen because Kyle and I will become the market makers...

Yep, this hypothetical amounts to - let's assume there are no more profit seekers. Once that assumption is in place the impact on publicly-traded stock prices is way down the list of economic problems that result.

avalpert wrote:Every buyer needs a seller - so someone is determining the price. Even if we assume all money is invested to track indexes the people managing that money (and thus executing the trades as needed) will be setting price against someone else on the other end of the trade - why wouldn't those prices be influenced by real-life events just as today?

If supply and demand for funds is all done based on market cap then how would a price get bid up or down? Funds would only need to balance inflows and outflows and would have to buy or sell all funds proportionally to maintain their index.

dspencer wrote:I think the issue is how do real-life events that should influence an individual company's stock get priced in when you can only make decisions to buy or sell the whole index. If Amazon has higher than expected profits or an auto manufacturer issues a major recall, how does that get reflected in their stock price if everyone has instructed the underlying traders to simply hold an amount equal to their market cap?

Well, in the short term it would barely be a blip. But over the longer term, companies get added and deleted from the Indexes all the time. That would be a way of rewarding or punishing those companies for their behaviors, wouldn't it?

And there are lots of indexes, right? With VG we are only exposed to some of them. Over time, evermore indexes could be created which would pigeonhole companies into other, overlapping niches. As the divisor (total number of companies in an index) gets smaller, the net effect of any one of the company's decisions which might cause a big move in its stock price can more affect the value of the index as a whole, with resulting index owner reaction.

It is still all about buying and selling at a nominal level. Even with indexes that shouldn't go away.

I can see where you are going but I think you are wrong. Let us just look at 2 sub-indexs, large cap and small cap. Market cap is determined by the market. If everybody was passive then Apple gets locked in at 3.7%. People might want small cap so they sell the large cap. Or the opposite. But there is nothing to push Apple from Large Cap to Small Cap or to change its percentage.

A Value / Growth slice would have a effect but not much of a one.

We don't even have to assume 100% passive. We can find real world examples where market forces are nurtured. I have mentioned the Nifty Fifty before. Or consider how extensive cross holdings affect Japan during the 90s. Lots of zombie high market cap firms. Firms with no economic value yet proped up. Or look at China today, where people have been jailed for reporting bad news about the stock market and the state props up bad companies.

You need many active investors to engage in active price discovery - to reward and punish companies. I am not sure how many we need nor have I seen any good academic literature on the level needed.

avalpert wrote:Every buyer needs a seller - so someone is determining the price. Even if we assume all money is invested to track indexes the people managing that money (and thus executing the trades as needed) will be setting price against someone else on the other end of the trade - why wouldn't those prices be influenced by real-life events just as today?

If supply and demand for funds is all done based on market cap then how would a price get bid up or down? Funds would only need to balance inflows and outflows and would have to buy or sell all funds proportionally to maintain their index.

Supply and demand isn't based on market cap at all - it is based on the funds need to spend/receive cash based on investors net inflows/outflows for the fund. The price for individual securities will get bid up/down based on two fund managers needing to come together and find an agreed upon price to clear their cash needs - if they both say they will take whatever the market price is it will be up to the market maker to set the price. If the price radically deviates from a fair price you will be back to having active investors jumping in to fix it (or we rest on the assumption that profit seeking has been banished from the realm and we wonder why that effect is limited to stocks and not all business activities and question why would we buy shares of businesses at all in that environment).

The funds need to execute trades in a way that tracks the proportionality of the index as close as possible is no different than what they do today - and it isn't nearly as simple as you might think but it is their jobs.

dspencer wrote:If supply and demand for funds is all done based on market cap then how would a price get bid up or down? Funds would only need to balance inflows and outflows and would have to buy or sell all funds proportionally to maintain their index.

Supply and demand isn't based on market cap at all - it is based on the funds need to spend/receive cash based on investors net inflows/outflows for the fund. The price for individual securities will get bid up/down based on two fund managers needing to come together and find an agreed upon price to clear their cash needs - if they both say they will take whatever the market price is it will be up to the market maker to set the price. If the price radically deviates from a fair price you will be back to having active investors jumping in to fix it (or we rest on the assumption that profit seeking has been banished from the realm and we wonder why that effect is limited to stocks and not all business activities and question why would we buy shares of businesses at all in that environment).

The funds need to execute trades in a way that tracks the proportionality of the index as close as possible is no different than what they do today - and it isn't nearly as simple as you might think but it is their jobs.

I just meant that market weighted indices demand more stock of companies with higher market caps when buying to accommodate net inflows and must sell more to accommodate net outflows. The whole point is who determines what is a fair price when the only motivation of buyers and sellers is to maintain market cap ratios? I think that is where one aspect of "chaos, catastrophe" comes into play. I agree that the scenario is totally unrealistic to the point of being kind of silly to discuss. I think that is Bogle's point: if everyone did this it would be a disaster, but that will never happen.

The more interesting question in my mind is whether there is a realistic percentage of passive ownership where the market efficiency degrades enough to undermine the strategy to some degree.

bottlecap wrote:If no one traded, markets would not operate. However, it takes very few participants to make a market work and if we hit the point where the market didn't work (became inefficient), more active participants would step in an start trading to make money off of the inefficiency.

The system would fix itself before it even became a noticeable problem.

And this is why I find myself sleeping soundly after recommending indexing to pretty much every wage earner who doesn't have the time, knowledge, motivation, and risk tolerance to make a reasonable attempt at trading to make money off the inefficiency.

Over the weekend, Bogle had said that a stock market that is 75% indexed would be a tipping point, but in the interview he backtracked. "What indexing does is neutralize a large part of the stock market. There's no trading in those stocks, or almost none," Bogle explained.

If that neutralization effect were to double to half the market, yes, trading levels would decline, Bogle said. "Turnover in the market is now around 250%. Theoretically, it would turn down to 125%," Bogle told CNBC.

Nevertheless, even at 125%, "that's a huge turnover," he said. "When I came into this business it was 25% a year.

Over the weekend, Bogle had said that a stock market that is 75% indexed would be a tipping point, but in the interview he backtracked. "What indexing does is neutralize a large part of the stock market. There's no trading in those stocks, or almost none," Bogle explained.

If that neutralization effect were to double to half the market, yes, trading levels would decline, Bogle said. "Turnover in the market is now around 250%. Theoretically, it would turn down to 125%," Bogle told CNBC.

Nevertheless, even at 125%, "that's a huge turnover," he said. "When I came into this business it was 25% a year.

I wonder how much of that turnover is due to Bogle? I only half joke. A big increase in trading is due to high speed arbitrager traders. One of the arbitrager techniques is with the unit creation of ETFs - If a funds NAV and share differ then high speed traders will push them together again. Since Vanguard has create a few ETFS, Mr. Bogle has been part of the processes.

To extend, I have never thought that stock volume was that important. A poor proxy for something deeper. What really matters is the type of trading that is going on. Warren Buffet does not trade much but has a huge impact when it comes to pricing.

alex_686 wrote:To extend, I have never thought that stock volume was that important. A poor proxy for something deeper. What really matters is the type of trading that is going on. Warren Buffet does not trade much but has a huge impact when it comes to pricing.

How does Warren Buffett have a "huge" impact on price setting? BRK has about $160 billion in marketable securities. That's a drop in the bucket when compared to the market as a whole, and they are largely "buy and hold".

This is much ado about nothing. As long as there are profit seekers out there prices will be set. It doesn't take "many active traders" to determine price; it takes a buyer and a seller. Regardless of whatever else is going on, indexers still own parts of the underlying businesses. I don't think large privately held firms like Samsung care that there aren't people setting their price constantly; I'm pretty sure if they want to sell they could find a buyer and agree on a price.

alex_686 wrote:To extend, I have never thought that stock volume was that important. A poor proxy for something deeper. What really matters is the type of trading that is going on. Warren Buffet does not trade much but has a huge impact when it comes to pricing.

How does Warren Buffett have a "huge" impact on price setting? BRK has about $160 billion in marketable securities. That's a drop in the bucket when compared to the market as a whole, and they are largely "buy and hold".

You have the right facts but you have come to the wrong conclusion. BRK doesn't buy and flip a few shares, they build stakes. If there is a 250% turnover each year, and 250 trading days each year, how long does it take to build a 5% stake? About a year. What about when it was 150% Once again, about a year. Ignore the sound and fury of the high frequency trades. It is the buy and hold folks that move the market.

Consider that the SEC has special disclosure rules when BRK trades to prevent market distortions. When BRK buys or sells a stock it moves the market. His deceleration that he will be a long term 5% stakeholder carries more weight than a high frequency trader.

You are right, it only takes 2 people to trade. However the motivations of those traders matter.

If there is a 250% turnover each year, and 250 trading days each year, how long does it take to build a 5% stake? About a year.

I am not getting the math here. Can you explain it please?

Well, my point is that the math behind the turnover numbers are kind of worthless. It does not matter much what the turnover in the stock market is to a buy and hold player. 150% or 250% or whatever, it takes a long time to build up a sizable position.

One of the reasons why the markets work is that traders are heterogeneous. Each type of trader helps determine price and thus provides price discovery.

On one extreme you have the high frequency traders. They affect the price by arbitrage. They don't really move the price up or down, their job is to keep spreads narrow. They balance out tight he supply and demand for a stock for very short periods. Very high turnover but not much depth. It is rare that they hold more than a few thousand shares at any time. Thus the sound and furry quote.

On the other exterm you have the buy and hold traders. Like Waren Buffet they tend to be fundamental investors. They will buy a company if they think it is undervalued by 20% they will start buying. Or if overvalued they will dump. It is these traders who tend to set the price for the long run.

Now, if Waren Buffet wants to buy 100,000 shares of a company where does he go? If thhe stock trades 20,000 shares a day he should be able to complete the order in 5 days, right? Alas no. 19,000 of those shares are actually just a few hundred shares that have very high turnover from high frequency trades whho are keeping the spreads low. Put in a big order and you are just going to bust through the bid / ask spread.

What Waren Buffet has to do is get other long term buy and hold investors to dislodge their shares. This takes time. I have seen no research that suggests buy and hold investors have changed their behavior. Plenty of studies that show that high frequency traders are getting faster and that this is causing spreads to narrow.

The S&P500 dumps stocks which are doing poor and buys stock which are doing great. That is its charter given it needs to keep the market cap ratio. That implies it is selling stocks which have low prices and buying stocks which have high prices. This goes against the tenet of buying low and selling high.

The S&P500 dumps stocks which are doing poor and buys stock which are doing great. That is its charter given it needs to keep the market cap ratio. That implies it is selling stocks which have low prices and buying stocks which have high prices. This goes against the tenet of buying low and selling high.

Where did I make a mistake in the above argument?

You are right. However, for the long term investor doing DCA, it doesn't matter.That price that seems high today, will be much higher many years down the road. Even with those "unintended" consequences of investing on SP 500 index funds, the index has an excellent Total Return record in the long term.

The S&P500 dumps stocks which are doing poor and buys stock which are doing great. That is its charter given it needs to keep the market cap ratio. That implies it is selling stocks which have low prices and buying stocks which have high prices. This goes against the tenet of buying low and selling high.

Where did I make a mistake in the above argument?

You are making a assumption. You are assuming that the companies being drooped are being priced low, that is they are undervalued. That is the market thinks it is worth $.90 while it is really worth $1. Conversely, you are assuming that the companies being added are overvalued. Why are you making this assumption?

To further muddy your waters, why do you think companies are being drooped? Maybe because of failure and bankruptcy. This might fit your investment thesis. Or maybe they are just lagging against the competitors. But this I mean they are still generating profits and delivering value to the shareholders, just not as much as the newer companies. Or maybe they left the index at their high - they merged with another company or were taken private.